I recently read a cautionary article about Apple (AAPL). The gist was that Apple is a good growth company, but the stock hasn't gone anywhere this year. Therefore, something must be wrong and investors should be cautious.
The problem with that logic is that it makes two improper presumptions. First, that a good growth company's stock usually rises steadily – or at least every couple of months. Second, when a stock stalls for a period of time, it is the harbinger of a reversal.
Actually, a "stall" is a natural occurrence. Here's why and how we should view such periods …
The pause that refreshes – during "stalls" stocks get into firm hands as fundamentals improve
As a stock climbs, it picks up trading interest. These traders are interested in short-term gains, so they sell quickly at the first sign of a slowdown. This selling can cause a hesitation in the stock's rise – hence, a stall.
During the stall, long-term investors take advantage of any price dips but are unwilling to chase the price up. They thereby put the stock into a sideways range (sometimes called a "box"). And that is where Apple has been for the past four months. Here's the picture …
(Click to enlarge)
The odd sign of a coming price rise: A price drop
Note that in the previous two stalls, Apple dropped to the low end of its range just before starting its next climb. Stocks seem to need this deep knee bend to jump upwards.
Importantly, these dips can be accompanied by signs that make investors anxious: Broken price barriers and/or moving averages along with double-digit percentage declines. This is similar to what's happening now (for more, see "Stock Market Buying Opportunity Could Be Coming" and "5 'Special Situation' Growth Stocks"). Such periods help clear out "weak" investors, putting the stock into stronger hands.
Does this mean Apple's stock price will soon rise?
Predicting time is very difficult. The stock market is notorious for not delivering results when we expect them. With that caution, there are positive indications that a new Apple stock price climb could start.
Fundamentals continue to improve – Apple's sales and earnings have continued to surpass expectations. Moreover, new and improved products and services, Apple's source for its remarkable expansion, are coming.
Competitors are following Apple's lead in its markets – Articles warning that Apple's market share will drop in the tablet (iPad) market are silly. The important point is that iPad has shown the way to make the tablet market a success. With competitors developing their own products and services, it means the market will grow and expand. Better for Apple to have 50% share of a large, robust market than to have 100% of a small, narrow one.
Valuation is especially good – The forward price/earnings ratio (using the next four quarters' earnings expectations) is now below 12 (the current P/E is 16). Financially, Apple can control its operations. It holds sizable cash, generates a large cash flow and has not borrowed.
Technical picture is good – With Apple's stock trading in its price range for four months, time could be on our side. The general market softness is creating ever better valuations – not only for Apple, but also for other successful companies. One investing truism is that, sooner or later, fundamentals will drive stock prices. When that happens, Apple's stock likely will rise out of its current range.
So … Apple's stock price stall looks like foundation building – not a topping out. Therefore, the current market softness could prove to be a good time to have bought shares.
Disclosure: I am long AAPL.
